Appeals from the United States District Court for the Western District of Wisconsin. No. 84 C 727 -- Barbara B. Crabb, Judge.

Author: Cudahy

Before CUDAHY and RIPPLE, Circuit Judges, and WILL, Senior District Judge.*fn*

CUDAHY, Circuit Judge

The defendant, Wausau Paper Mills Company ("Wausau Mills"), purchased an all-risk property insurance policy from the plaintiff, Arkwright-Boston Manufacturers Mutual Insurance Company ("Arkwright"). Wausau Mills subsequently attempted to recover under that policy the costs of repairing damage to a reactor it owned and operated. Arkwright denied the claim, maintaining that the damage was not an insured risk under the terms of the policy. The district court entered summary judgment in favor of Arkwright.

I.

Wausau Mills manufactures and sells paper. It purchased an all-risk insurance policy from Arkwright covering the period from January 1, 1983 to January 1, 1986. The policy insured, Wausau Mills "against all risks of direct physical loss or damage, except as hereinafter excluded, to the property described hereinafter . . . ." Property Damage Policy, Plaintiff's Supplemental Brief in Support of Motion for Summary Judgment, Exhibit 5, at 5915. The policy also contained the following provision enumerating certain exclusions from coverage:

C. EXCLUSIONS

Group B This Policy does not insure against:

4. Deterioration, depletion, inherent vice or latent defect, rust or corrosion, mold, wet or dry rot, erosion, or wear and tear unless physical damage not otherwise excluded by this Policy results, in which event, this Policy shall cover only such resulting damage[.]

Id. at 5919.

Among the property covered by the policy was the Copeland Recovery Reactor (the "reactor") located at Wausau Mills' paper mill in Brokaw, Wisconsin. The reactor is a three-story, thirty-eight-foot tall vessel in which certain by-products from the paper mill are burned in order to recover chemicals for reuse in the papermaking process. The walls of the reactor are composed of two layers of brick covered by an exterior steel shell whose thickness varies from 1/2 inch to 3/8 inch. The normal operation of the reactor produces several chemicals, including sulfur dioxide (SO[2]), sulfur trioxide (SO[3]) and water (H[2]O). If the temperature of the interior surface of the steel shell drops below the dew point of sulfuric acid H[2]O and SO[3] condense on the steel shell as H[2]SO[4] -- sulfuric acid. Hot sulfuric acid is highly corrosive to steel; it can cause thinning and pitting (i.e., the creation of holes) in the steel.

The reactor was designed and installed in 1965 and 1966. Damage to the reactor due to the condensation of sulfuric acid first occurred in 1970. In that year, many holes, as well as general thinning, were discovered in the steel shell. As a result, the reactor was shut down and all but the foundation was replaced. A lining was placed between the brick and the steel shell, in part to protect the shell from corrosion.

Corrosion did not again interfere with the operation of the reactor until late 1978, when eight to ten holes were discovered in the steel shell. Again, corrosion due to the condensation of sulfuric acid was determined to be the cause of the damage. Representatives from the company that built the steel shell and the company that supplied the brick lining advised Wausau Mills that the reactor would have to be replaced "in the very near future." Wausau Mills decided not to replace the reactor or the steel shell at that time. Instead, it placed half-inch thick carbon-steel patches over existing holes and thin spots, installed thermocouples which monitored the shell temperature and insulated the exterior of the reactor.

In October 1982, Wausau Mills installed a new sulfur scrubber system to remove sulfur dioxide (SO[2]) from the gases emitted from the reactor. The addition of the scrubber system lowered the operating temperature of the reactor and the reactor shell. The lower temperatures resulted in poor chemical recovery and also created the danger of future corrosion. The temperatures began to rise in December 1982 but remained below normal until May 1983. In July 1983, Wausau Mills discovered and patched two small holes in the steel shell. In September 1983, numerous ...

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